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L E K . C O ML.E.K. Consulting Executive Insights
EXECUTIVE INSIGHTS VOLUME IX, ISSUE 3
Creating Ancillary Revenue Opportunities: Rethinking the Airline Selling Proposition
Creating Ancillary Revenue Opportunities: Rethinking the Airline Selling Proposition was written by John Thomas, Vice President and Dan McKone, Vice President in L.E.K.’s Boston office. Please contact L.E.K. at [email protected] for additional information.
For years, investors and other industry
observers have impugned the airline
industry’s long-run commercial viability.
They point to such “structural flaws”
as low barriers to entry, high fixed costs,
undifferentiated service, intractable factor
costs (fuel and labor) and consumers’
ever-increasing ability to find the
lowest price.
However, regarding the airlines as purely
a commodity business with unattractive
economics is ignoring a subtle but
powerful trend that is making major
inroads in the industry. A small but
growing number of savvy carriers are
competing on another dimension:
viewing airplanes as a channel for selling
a broad range of products and services,
rather than simply a means of
transportation. The term the industry
uses to describe this phenomenon is
“ancillary revenue.”
In this issue of Executive Insights, we
draw on our experience in identifying
ancillary revenue for several major
carriers, providing a way for airlines to
think more expansively and create new
revenue opportunities.
An Untapped Revenue Source
Ancillary revenue at most airlines is a very
small percentage of the total top line.
However, carriers such as Ryanair, easyJet
and Allegiant are showing that giving
consumers a much broader range of
choices for how they spend their money
before, during and after their flight can
generate significantly higher returns.
L.E.K. Consulting’s research suggests that
even these airlines are just scratching
the surface and that there is a significant
chance of greatly expanding the industry’s
overall revenue potential.
Numerous industries with high fixed costs
have successfully layered additional offer-
ings onto their core products and services.
Consumer electronics retailers derive
much of their margin from warranty
and, increasingly, services revenue; hotels
generate significant earnings from food,
beverage and in-room services; and ship-
ping firms capture additional sales from
optional services related to the timing,
handling and security of package
delivery. In each case, these ancillary
revenue streams have become core drivers
of profit. Such examples demonstrate
that it is possible to unbundle a product
offering and make the base service more
affordable to some consumer segments
while creating more options for others.
The result is higher revenue and profit
than a one-size-fits-all plan confers.
Airlines, too, can create ancillary revenue
opportunities. Airlines’ customer demo-
graphics are something most retailers
yearn for: a captive audience with
substantial spending power– namely,
business people with minimal time to
shop and vacationers who are already
relaxing their wallet.
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L E K . C O MPage 2 L.E.K. Consulting Executive Insights Vol. IX, Issue 3
Realizing this, airlines for years have tried
to upsell their passengers, encouraging
them to upgrade to first class, buy prod-
ucts through Skymall and other in-flight
magazines, make satellite phone calls,
and pay extra for alcoholic drinks and
movies. Airlines also increasingly entice
passengers to book other travel purchases
through their websites, such as hotels,
rental cars and entertainment, from which
they take a fee.
Despite having access to attractive
consumer segments, only a few airlines
today generate significant ancillary
revenue. The airlines that do – Ryanair,
easyJet and Allegiant among them – tend
to have non-traditional business models.
However, from our discussions with
numerous established carriers, the rest
of the industry has begun taking notice
of these airlines’ success and the
opportunities they reflect.
While it has become increasingly difficult
for airlines to show incremental gains
on top of the significant cost-cutting
strategies they have pursued in recent
years, our analysis suggests a legacy
airline can generate at least 10% more
highly profitable revenue from a successful
ancillary revenue strategy. For a major
U.S. airline, this could translate into hun-
dreds of millions of dollars in additional
annual earnings.
Specifically:
• They do not associate airline-supplied
products with high quality
• They do not view ancillary offers to
be a good value for the money
• They have an ingrained reluctance
to spend money in-flight through
a long-held belief that all onboard
amenities should be included in the
ticket price
Many airline executives have other,
non-operational concerns about
launching ancillary revenue strategies.
One is that selling more frills to economy
passengers would dangerously blur
the distinction between first-class and
economy service. The experiences of
several airlines, and L.E.K.’s consulting
work with a number of major carriers,
suggests otherwise. Airlines could offer
a range of products and services to
first-class and economy passengers while
keeping their flight experiences very
distinct. This requires unbundling the
“hard” product (passengers’ seat experi-
ence) from the “soft” product (food,
drinks, etc.). Our research has found that
first-class passengers choose this level of
service primarily because of seat comfort,
not for the better meals, drinks and other
amenities that come with it.
Why So Few Successful Ancillary Revenue Strategies?
There are several reasons why few airlines
have effective ancillary revenue strategies.
One key obstacle has been that onboard
sales efforts have simply been ineffective.
Most flight attendants view their jobs
as being about safety and service, not
selling, and they have not been given
appropriate incentives to alter their
perceptions and behavior. Also, airlines’
limited success in selling such products
as in-flight phone services and products
from onboard catalogs has dampened
their enthusiasm for new creative initia-
tives. Furthermore, operational problems
have diminished their interest – such as
the historical difficulties of in-flight credit
card authorizations, weight and space
restrictions, and the challenges of
delivery in airports.
Perhaps the most significant reason
airlines have been unsuccessful in
generating meaningful ancillary revenues is
that they do not have a deep understand-
ing of consumer retail behavior. Indeed,
L.E.K.’s surveys of thousands of passengers
show they have not been enthusiastic
about many airlines’ early attempts at
ancillary products and services.
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L E K . C O MPage 3 L.E.K. Consulting Executive Insights Vol. IX, Issue 3
A number of airline executives also
believe that the pursuit of ancillary
revenue will antagonize passengers who
feel they are being charged for items
that were previously included as part of
the ticket price. This does not necessarily
need to be the case, as some airlines have
been able to decouple standard services
from the price of a seat without losing
customers. Furthermore, a number of
the products with which there have been
early successes, such as trip insurance,
are incremental benefits to the customer.
They have not been stripped out and
provided for a separate fee and are in fact
new offerings. By clearly communicating
to customers that it can lower fares by
separating out the incremental perks and
providing new and appealing options, a
carrier can assuage passenger concerns.
Developing an Ancillary Revenue Strategy
Since the current passenger mindset has
been a powerful barrier to introducing
new and exciting revenue opportunities,
airlines must first address this issue. To
this end, L.E.K. has developed a strategic
approach, the Passenger Value Frame-
work, for changing consumers’ onboard
mindsets and buying behavior
(see Figure 1).
1 Allegiant Travel Company SEC Form S-1, Preliminary Prospectus dated August 23, 2006, and company website (AllegiantAir.com).
Ample evidence suggests that ancillary
revenue can be highly profitable in the
airline industry. Ryanair’s ancillary revenue
in fiscal 2006 jumped 36% to E259
million, accounting for 17% of total
revenue. The airline charges extra for
checking bags and other items, and has
stated that it plans to launch an online
gambling service for passengers. Al-
legiant, a Las Vegas-based carrier with
annual revenue of about $240 million,
generated 17.5% of its revenue from
ancillary products and services in 2006. At
this stage, Allegiant’s products are mainly
disaggregated parts of the standard offer;
it charges for beverages, snacks, pillows,
souvenirs from its travel destinations and
dining coupon books. It also unbundles
and charges for booking fees, checked
bags and seat assignments. ¹
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L E K . C O MPage 4 L.E.K. Consulting Executive Insights Vol. IX, Issue 3
The first step in this process is introducing
products and services with strong appeal
to the broadest number of passengers.
Such “core” products should be familiar
to most consumers, have low inherent
purchase risk, and provide immediate and
relevant benefits. Core offerings can be
derivations of products and services with
which airlines are already familiar. These
include enhanced meal and wine offer-
ings, premium baggage services, tempo-
rary lounge access, elite parking and car
services, and express airport access.
When an airline has established this first
generation of core offerings, it will have
created a new and higher standard for
in-flight products and services. In the
process, it will have made customers
much more receptive to additional
offerings that will improve the travel
experience. At that point, it can introduce
a second wave of “impulse” and “niche”
products and services. These should
appeal to a small but loyal base of
passengers with greater disposable
income and a willingness to spend it
during air travel. Figure 2 illustrates the
major stages for rolling out an ancillary
revenue strategy.
Key Risks and How to Address Them
One risk of aggressively pursuing
ancillary revenue is introducing a bevy
of new products and services that
overwhelm customers and airline and
airport operations. Airlines must survey
customers and conduct rigorous analysis
of potential core, impulse and niche
product offerings to ensure they have
the right mix and can deliver them
flawlessly. They must understand how
much customers value each offer and at
what price points. For example, L.E.K.’s
research has shown that a surprising
number of passengers would expend
significant money for a better meal on
even a short-haul flight.
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L E K . C O MPage 5 L.E.K. Consulting Executive Insights Vol. IX, Issue 3
As discussed above, while success has
been shown in adding new services,
airlines must be careful not to offend
customers with ancillary revenue pro-
grams that add fees for already existing
services. Carriers whose loyalty programs
currently provide free priority check-in
and boarding, for example, would be
wise not to begin charging for these
services. Taking away incremental benefits
from key customers could sour them on
the airline.
Two other major obstacles are increased
operational complexities and payment
risks. Guarding against the first requires
an airline to offer products that it can
deliver through its current infrastructure.
To address the payment risk obstacle,
airlines must drive customers to purchase
products and services at the time they
book their tickets rather than en route,
while working to make onboard
purchases as seamless as possible.
Ultimately, airlines will need to exploit
evolving technological advances so that
they can know at the moment a passen-
ger makes a reservation what products
and services to offer him or her before,
during and after the flight.
Payment is an exceptionally large and
complicated challenge. However, major
airlines have launched initiatives to facili-
tate multi-point purchase and to-the-seat
credit extension. As in-flight broadband
Internet service moves from satellite-
based technologies to terrestrial-based
and hybrid solutions, its wider availability
will significantly enhance the ability of
airlines to provide onboard offerings.
Airlines that effectively lay the ground-
work by making passengers more
receptive to onboard offerings now will
be better poised for significant growth
– well beyond what they generate from
ancillary offerings today.
Don’t Be Left at the Gate
In their efforts to capture incremental
gains, most airlines have fully exploited
the traditional levers available to them,
such as cost-cutting, loyalty programs and
yield management systems. To create new
opportunities to improve both their top
and bottom lines, carriers should move
aggressively to improve and better sell
their existing ancillary offerings as well as
identify, test and plan the rollout of new
ancillary products and services.
While some recent investments in in-flight
entertainment technology have certainly
been substantial, airlines can generate
the first wave of significant revenues
without the help of advanced consumer
technology. Furthermore, carriers that
wait until competitors prove the market
for new products and services may lose
passengers. On the other hand, airlines
that move quickly and invest strategically
in this area will be able to increase profits
without competing in the zero-sum game
that has become the industry norm.
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L E K . C O MPage 6 L.E.K. Consulting Executive Insights Vol. IX, Issue 3
L.E.K. Consulting is a global management consulting firm that uses deep industry expertise and analytical rigor to help clients solve their most critical business problems. Founded more than 25 years ago, L.E.K. employs more than 900 professionals in 20 offices across Europe, the Americas and Asia-Pacific. L.E.K. advises and supports global companies that are leaders in their industries – including the largest private and public sector organizations, private equity firms and emerging entrepreneurial businesses. L.E.K. helps business leaders consistently make better decisions, deliver improved business performance and create greater shareholder returns. For more information, go to www.lek.com.
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